Thug Island Dreamin’

If a reality show can decide someone’s spouse, can resolving geopolitical tensions in a primetime program be that far away? Photo by Vince Bucci/Getty Images Entertainment.

The most noble of would-be beauty queen ambitions—world peace—seems as unattainable today as ever, to those attuned to headlines. Egypt, where 2011’s army-led revolution unseating Hosni Mubarak preceded the angst that led to democratically elected President Mohammed Morsi’s ouster in a military-led coup d’etat, is a mess. Syria’s civil war continues raging and, by some accounts, has claimed the lives of more than 100,000. Iran has a new president and, as of Thursday, also has possession of a new mid-size oil tanker that happens to be the legal property of an Indian oil firm. In other words, the Middle East is doing its best impression of, well, the Middle East. But tensions aren’t limited there—the US issued a global terrorism warning, and who can forget North Korean dictator Kim Jong Un. The world, it seems, is not a totally safe place—tautology, I know. For investors, geopolitical tensions can often spark fears—fears some crazy dictator in a far-flung part of the globe might derail the bull market. However, history suggests the fear is greater than the reality, its impact fleeting and long-term investors needn’t worry themselves with the inner workings of the dictatorial mind.

Many folks on Wall Street often propagate the myth that geopolitical considerations are a major global market input. There is a whole industry of folks who write interesting—yet largely irrelevant for investors—commentary regarding the inner workings of some brutal pest’s brain. Or what certain world leaders are really thinking. Yet little to no evidence suggests they consistently possess such insights or, more importantly, that such insights really amount to much for investors. The inconvenient fact for those with a geopolitical focus is the vast majority of the time, history has shown geopolitical tensions’ impact on markets to be small and brief. In fact, there is only one historical instance in which geopolitical tensionsaffected the market cycle—shifting from bull to bear. What’s more, markets often steady when outright conflict occurs.

To illustrate, consider the tensions leading up to the first Gulf War. After Saddam Hussein’s Iraq invaded Kuwait in the summer of 1990, tensions between the US and Iraq escalated quickly, peaking during the failed Geneva talks of December 1990 – January 1991. Stocks’ reaction? The S&P 500 fell 6%.ⁱ And those fears were alleviated when Operation Desert Storm commenced in January 1991. Some might say the quick evaporation of fears, or the lack of impact, is because Iraq was a weak opponent. But that wasn’t clear until well after the war was underway. In the run up, most folks speculated the Republican Guard was a relatively effective fighting force.

In 1950, North Korea invaded South Korea and the S&P 500 sold off roughly 14%ⁱⁱ from mid-June to mid-July—a textbook correction, as stocks seemingly anticipated US entry into the conflict. By September’s close, stocks regained and surpassed pre-invasion levels. When the Chinese crossed the Yalu River and joined North Korean forces in late October, stocks initially rose before falling about 6%ⁱⁱⁱ—not a big reaction, and again, a level regained in a few weeks.

The Tet Offensive. JFK’s assassination. The Cuban Missile Crisis. The Iraq War (second Gulf War, if you prefer). These are all very important historical events, of course. Yet stocks’ reactions weren’t very big at all. Even after the horrific tragedy of 9/11, stocks regained pre-attack levels in 19 trading sessions. (Only to give them up as the dot com bear market, which began March 24, 2000 continued until late 2002.)

There is one—and only one—bear market with geopolitics as its proximate cause: the run up to and outbreak of World War II. Tensions truncated 1938’s nascent bull market—a sharp rally higher off of a relative low in March 1938 was flattened in July, as Hitler’s ambitions for Czech territory became clear. By the time late September’s Munich agreement ceded the Sudetenland to Germany—another measure designed to “appease” Hitler’s territorial lust—the S&P had declined roughly 11%.^iv And there it hovered for a time. However, after Poland’s invasion by the Nazis led to Britain and France declaring war, stocks briefly spiked (+9% in the immediate aftermath of the two Western powers declaring war on Germany)—tensions were seemingly alleviated by war.^v But then the real surprise struck: France’s sheer ineptitude. Stocks fell 25% in a number of days as the Maginot Line proved more a punch line than a line of defense.^vi Pearl Harbor was a similar surprise, though not as extreme. Ultimately, though, a new bull market began in 1942—years before the war’s end, even before Allied victory was foreseeable.

Absent some massively surprising event—a broad, global conflict involving major powers—it’s quite unlikely stocks would react for long to geopolitical tensions. Hence, not only is it nearly impossible and futile for investors to try to divine Kim Jong Un’s “logic,” it’s unnecessary. Instead, investors would be better served analyzing more boring factors: economics, sentiment, potential legislation, international trade policy and more.

Accepting this point isn’t seeing the world with rose-colored glasses, it’s being a realist, accepting that we don’t live in a world where every leader has good intentions—and that it’s impossible to always know what their intent is. Maybe someday a fix will be found—the global solution to tyrannical thugs. Hey! Maybe it’s a reality show on an otherwise uninhabited desert island in the Mediterranean, in which the Kim Jong Uns and Castros compete in feats of strength, cunning, propaganda and secret policing! Maybe we can even get a beauty queen to host. But for now, these visions of a Thug Island, where the dictatorially inclined can only wreak their havoc on one another, are merely dreams.